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September 8, 2009

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Reference ID Created Released Classification Origin
09KYIV1531 2009-09-08 15:35 2011-08-30 01:44 CONFIDENTIAL Embassy Kyiv

DE RUEHKV #1531/01 2511535
R 081535Z SEP 09

C O N F I D E N T I A L SECTION 01 OF 02 KYIV 001531 
E.O. 12958: DECL: 09/07/2034 
REF: KYIV 01519 
Classified By: Economic Counselor Edward Kaska for Reasons 1.4 (b) 
and (d) 
1. (SBU) Summary.  IMF's Resident Representative in Ukraine, 
briefing on mission director Ceyla Pazarbasioglu's 
"stocktaking" visit to Kyiv, commented that he has doubts 
about Ukraine's intention to live up to its commitments and 
expressed concern over Ukraine's ability meet its budget 
obligations past September.  He observed that bank 
recapitalizations were proceeding relatively well and that 
tax and pension reform committees had been formed and were 
meeting.  However, the independence of the central bank and 
its ability to withstand pressure to monetize budget 
shortfalls remained uncertain.  As a result of unmet 
commitments, the IMF is considering where to draw the line as 
it approaches negotiations for the fourth tranche.  End 
2.  (SBU) Max Alier, the IMF's Resident Representative in 
Ukraine, briefed the US, UK, French, German, Canadian, and 
European Commission diplomatic missions in Kyiv on Saturday 
afternoon.  Alier reported on the September 1 - 4 visit of an 
IMF team to Kyiv to assess the state of the IMF's standby 
program in Ukraine.  The IMF visiting team was led by Ceyla 
Pazarbasioglu who has headed the previous IMF Mission visits 
to Ukraine. 
3.  (SBU) Alier stressed that the staff visit was not a 
negotiation but what he called a "stocktaking" of the IMF 
program and preparations for a late October visit to Kyiv, 
when a formal IMF review mission and negotiations concerning 
a fourth IMF tranche will occur.  Alier stated that the past 
week of meetings between the IMF and GOU (from the "PM on 
down") had been intense and had not gotten off to a good 
start when a Ukrainian paper on August 31 published an 
interview Alier had given to it earlier on August 7.  Alier 
in his interview comments had noted that the IMF would not be 
a party to an irresponsible GOU budget. 
4.  (SBU) Gas prices:  The first "bad news" from the visit 
was the GOU's failure to implement a commitment to raise gas 
prices for households by 20% on September 1.  The GOU claimed 
a failure to win trade union approval of the increase as 
required by "law" and a court injunction against the NERC 
prevented the increase.  GOU officials said they planned to 
implement a promised 20% increase on energy producers on 
October 1 which does not face the same legal hurdles.  Alier 
could not reconcile what GOU officials had told him this past 
week about gas prices and PM Tymoshenko's earlier statement 
in western Ukraine that there would not be a gas price 
increase before January 2010 elections.  Alier volunteered 
that if the GOU really wanted to do something that it seemed 
always to find a way to do it, but he could envision a 
situation where the barriers to a price increase on household 
gas could drag on "forever". 
5.  (SBU) Fiscal Situation:  Alier noted the GOU fiscal 
situation is "very tight" and "they cannot make it on their 
own," and as such the GOU must get a fourth IMF tranche or 
find another funding source.  The recent payment for August 
gas had come from a VAT refund due Naftohaz, which in turn 
used it to pay Gazprom.  Alier said September will be "tight" 
and "we'll see what they do in October".  He expects Ukraine 
will "close the tap" and import little Russian gas in 
September, and that October will be a very difficult month 
for the GOU, as a fourth tranche of $3.8 billion, if 
approved, can only be disbursed in mid-November.  Alier noted 
that negotiations over a fourth tranche, which the GOU wants 
to be used solely for budget support, will be difficult. 
Alier speculated that Tymoshenko has been negotiating with 
Putin to win Russian financial aid, and that she would "care 
less" about the IMF program if she could find bilateral funds 
to fund the budget. 
6.  (SBU) 2010 Budget:  Alier indicated it is too soon to 
review the GOU's 2010 budget.  The IMF wants the GOU to 
produce a 2010 budget with no more than a 3.0% budget deficit 
(4% with Naftohaz subsidies included), but the GOU has been 
indicating a 3.75% (before Naftohaz subsidies) deficit is in 
order.  Alier added that the GOU's revenue projection for 
2010 was "quite large" and that the numbers would get closer 
scrutiny from an IMF budget team that will visit Ukraine this 
week.  The Cabinet of Ministers faces a September 15 deadline 
to submit a budget to the Rada (parliament). 
7.  (SBU) Bank Recapitalization:  Alier expects that bank 
KYIV 00001531  002 OF 002 
recapitalization will be completed by the end of 2009 and 
that the 2010 budget will not have to take account of funds 
for bank recapitalization.  He expects the resolution process 
at UkrpromBank would be completed first, which is a less 
complicated situation than that at Nadra Bank.  Alier added 
the NBU will handle small problem banks and t
hat these were 
not really recapitalizations, as the banks will be merged or 
8.  (SBU) NBU Independence:  Alier noted the NBU, which falls 
under President Yushchenko's purview, thus far was "not 
cooperating fully with monetizations."  The NBU had not 
implemented a recently passed law requiring it to provide UAH 
10 billion to fund the hosting of the Euro 2012 soccer 
tournament, and the NBU had not delivered on an alleged deal 
between PM Tymoshenko and NBU Head Stehlmakh to monetize the 
repayment of Naftohaz bonds.  Alier believes that NBU 
monetization of the budget gap is "not a high possibility," 
but whether the NBU can ultimately resist pressure to 
monetize the budget gap remains to be seen.  Alier stated it 
will be a matter of public relations, claiming that if the 
GOU could not pay wages in the autumn it would blame the NBU, 
thus placing the NBU in the position of defending its 
policies.  Alier noted the Rada had failed to pass 
legislation ensuring the NBU's independence, a condition of 
the IMF program, and that GOU-NBU tensions were "running 
high."  He also observed Stehlmakh was "on vacation" again 
and apparently not involved in day to day NBU operations. 
9.  (SBU)  Exchange Rate:  Alier said "liquidity injections" 
and "panic in the population" were driving recent hryvnia 
depreciation.  Repetition by television stations (which Alier 
characterized as owned by oligarchs with export oriented 
businesses that would welcome further depreciation) of 
stories about an autumnal decline of the hryvnia could become 
a self fulfilling prophecy.  Alier noted the  NBU's official 
exchange rate "makes no sense" and does not comply with the 
IMF condition that it be kept within 2% of the market rate, 
and the NBU was facing the issue of "how much do you let it 
go" in terms of UAH depreciation. 
10.  (SBU) Budget Code:  The GOU, according to Alier, is 
trying to "sneak by" again a new budget code that would allow 
more funds to be sent to the regions.  The IMF is not opposed 
to decentralization, but the proposal is not the way to do 
it.  Tymoshenko was meeting with 12,000 local government 
officials this week. 
11.  (SBU) Bright Spots:  Alier said that committees to work 
on pension reform and tax reform are formed and were meeting. 
  However, he did not expect any substance out of the reform 
committees before the January 2010 elections.  He also 
indicated that the GOU had agreed to a "monitoring committee" 
where the IMF meets all with all parts of the government 
affected by an issue (the committee membership changes with 
the issue) and that in fact the commission had met with the 
IMF team during their visit.  Alier expressed the hope that 
the monitoring committee would begin regular biweekly 
meetings with the IMF team. 
12.  (SBU) Istanbul Meetings:  Alier sees no serious 
negotiations between GOU and IMF in Istanbul, as relevant 
staff (including Pazarbasioglu and Alier) will not be there. 
13.  (SBU) The Executive Board:  Pazarbasioglu will consult 
with IMF management in Washington, and several Executive 
Directors already have requested meetings with her.  Alier 
believes a "decision" regarding the direction of the IMF 
program in Ukraine cannot wait until November and he expects 
IMF management will "be reaching out to capitals" and that 
the IMF Mission to Ukraine will soon "get some parameters" 
from Washington.  Alier noted that a decision regarding 
"where you draw the red line" is needed from Washington, and 
then added that when the IMF leaves a country it does not 
formally announce that it is walking out. 
14.  (C) Comment:  In the run-up to Ukraine's January 
presidential election, it is difficult to envision PM 
Tymoshenko making the hard, necessary reforms to which she 
has previously committed, even if the IMF threatens to walk 
away from future disbursements.  As Alier alluded, if 
negotiations for the IMF's fourth tranche prove to be 
difficult, PM Tymoshenko will attempt to secure other funding 
sources -- including bilateral support from Russia -- as well 
as pressure the NBU to monetize any budget shortfall.  Such 
actions by Tymoshenko would be a significant setback for the 
reform process in Ukraine.  End Comment. 




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